February 21 – CNBC (John Carney): “The Washington Post ran a long and well-wrought article on Modern Monetary Theory over the weekend. The piece, by Dylan Matthews, starts with Jamie Galbraith’s experience trying to explain to a large audience of economists in the Clinton White House that the budget surpluses the federal government was running was immensely destructive. Or, rather, it starts with those economists laughing at Galbraith’s attempt to explain this. It was obvious to me way back before I had ever heard of MMT that governments should probably never run a budget surplus—or should do so only in dire emergencies. When the government runs a surplus, that means it is taking more money out of the economy than it is spending back into the economy. It is making us poorer.”

In my initial CBB back in 1999, I trumpeted the need for a Contemporary Theory of Money and Credit. Some thirteen years later, I lament that the void remains as large as ever. Mr. Matthews’ Washington Post article highlighted “Modern Monetary Theory,” an alternative economic framework with Keynesian roots that is receiving heightened attention in our age of unrelenting government stimulus. I will not be jumping on board.

From Mr. Matthews’ article: “‘Modern Monetary Theory’ was coined by Bill Mitchell, an Australian economist and prominent proponent, but its roots are much older. The term is a reference to John Maynard Keynes, the founder of modern macroeconomics. In ‘A Treatise on Money,’ Keynes asserted that ‘all modern States’ have had the ability to decide what is money and what is not for at least 4,000 years. This claim, that money is a ‘creature of the state,’ is central to the theory. In a ‘fiat money’ system like the one in place in the United States, all money is ultimately created by the government, which prints it and puts it into circulation. Consequently, the thinking goes, the government can never run out of money. It can always make more.”

And from Wikipedia: “Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money, i.e. fiat money… The modern theoretical body of work on chartalism is known as Modern Monetary Theory (MMT). MMT aims to describe and analyze modern economies in which the national currency is fiat money, established and created exclusively by the government. In MMT, money enters circulation through government spending; Taxation is employed to establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation… Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government’s deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities per se.”

My “contemporary theory…” takes an altogether different approach. “Money” is not foremost a creature “ultimately created by the government,” but is instead primarily an issue of market perceptions. “Money” is as money does (“economic functionality”). The reality is that we today operate in an age of globalized electronic Credit – a comprehensive virtual web of computerized general ledger debit and Credit entries linking creditors and debtors round the globe. This “system” of electronic IOUs comprises myriad types of financial obligations of diverse structure, maturity, Creditworthiness and currency units of accounts. Importantly, if the marketplace perceives that a Credit instrument will act as a highly liquid and stable store of nominal value, this Credit enjoys “moneyness.” It is the nature and nuances of contemporary marketable debt – especially with respect to the prominence of governmental and central bank support - that should be the analytical focal point. A static view of government-based “fiat money” is anachronistic.

Economists argued in the late-nineties that government budget deficits were a “fiscal economic drag.” They later claimed that the 2001 recession proved their point. Many of these same economists today support ongoing massive deficit spending. They fret over the thought of “austerity.” I take issue with this line analysis, especially from a monetary theory perspective.

First of all, it’s generally inaccurate to claim that government surpluses “take money out of the economy” and “make us poorer.” To this day, the economic community fails to appreciate key monetary dynamics from the nineties – issues that remain just as relevant today. The federal government ran a small surplus in 1998, a surplus of about $100bn in 1999 and one approaching $200bn in 2000. There was talk of paying down the entire federal debt. Economists and policymakers alike were oblivious to momentously destabilizing developments in “money” and Credit. We’ve made little analytical headway since.

Nineties’ surpluses were primarily driven by a massive inflation of government receipts. In the five year period 1995-2000, federal revenue surged 46% to $2.057 TN. Over this period, federal spending rose 16% to $1.872 TN – hardly a fiscal drag and harbinger of recession. Why were receipts exploding? Well, because system Credit was surging. In the four years ended in 1999, total U.S. marketable debt jumped 37% ($6.9TN) to $25.389 TN. The annual growth in system marketable debt increased from 1995’s $1.196 TN to 1999’s $2.070 TN. In four years, Non-Financial debt expanded 27% ($3.6TN) to $17.291 TN, although the real fireworks were courtesy of an evolving financial sector.

In the four years ended 1999, total Financial Sector borrowings jumped 74% ($3.1TN) to $7.349 TN. What was driving this historic growth? Primarily the GSEs. In just four years, GSE Credit obligations (agency debt and GSE MBS) jumped 64% ($1.5TN) to $3.888 TN. And with rampant GSE Credit growth ensuring market liquidity abundance, outstanding Financial Sector corporate bonds jumped 56% in four years, while the Asset-backed Securities (ABS) marketplace doubled. CPI may have been relatively tame, but Credit and speculative excess were fueling historic asset market inflation. And asset market capital gains – bonds, tech stocks, houses, etc. – were helping fill government coffers (and boosting expenditures!) from Sacramento to WashingtonD.C.

I’m not sure how a modern monetary theory can be relevant without delving deeply into the profound role the evolution of GSE and Wall Street finance had on U.S. and global finance; on the fiscal position of the U.S. and advanced economies; on our asset markets, economic structure and on financial fragility more generally. To focus on federal spending, surpluses and deficits at the expense of recognizing the momentous distortions wrought by Washington finance (Treasury, GSE and Federal Reserve – OK, throw in the IMF and World Bank) is a failure of analytical diligence.

The 2008 crisis and subsequent economic and financial fragilities were a direct consequence of a historic Bubble in mortgage finance. Washington’s fingerprints were all over the mispricing of finance that fueled near-catastrophic asset market distortions and economic maladjustment. It was an abject failure in policymaking. Those that have called for even greater government involvement in our economy and markets are content to disregard past mistakes. For those of us paying attention, there’s no doubt that we want Washington extricated from monkeying with market pricing mechanisms.

The lack of respect for “money” and moneyness is a primary issue I have with most monetary analysis. They don’t get it. From the perspective of my analytical framework, money is both powerful and precious. Historically, sound money has been as rare as government-induced monetary inflation has been commonplace. The biggest risk coming out of the 2008 crisis was that runaway Washington fiscal and monetary stimulus would destroy Creditworthiness at the heart of our monetary system. We're well on our way. Throughout history, mistakes in monetary management have tended to beget only bigger mistakes.

Somehow, many “monetary” economists seem to believe that money is like Doritos chips: don’t fret, quite easy for us to make a lot more. After witnessing the consequences of a collapse in confidence in Wall Street Credit and, more recently, the Credit obligations of Greece and Portugal, there is no excuse for such complacency. Yet conventional wisdom holds that Washington will always enjoy the capacity to “print” its way out of trouble. Default risk is a myth, it is believed. It is similar thinking that ensured the spectacular mortgage Credit boom and bust. It is one thing to issue fiat currency; it is quite another to sustain market confidence when Credit is expanding uncontrollably.

The GSE/mortgage monetary inflation was not as conspicuous. Today, we are witnessing in broad daylight the dangerous side of “money.” The Treasury is issuing Trillions of debt - in an environment of virtually insatiable demand. Over the years, I’ve noted how a boom fueled by risky junk bonds wouldn’t be that dangerous from a systemic point of view. Limited demand for junk would create self-imposed market constraints. A Bubble in “money,” on the other hand, would tend to last longer, go to greater excess and, as such, have much greater deleterious impacts on financial and economic structures. And severe structural impairment can require multi-decade workouts and restructuring periods (think Great Depression and Japan). Money, even in its modern form, remains precious and, potentially, extremely dangerous – and this is the bedrock of my Contemporary Theory of Money and Credit.

Fine, economists can sit around and debate deficit spending and the role of fiscal stimulus in recessions and recoveries. Meantime, there is scant discussion of the extraordinary monetary backdrop and untested experimental nature of monetary management. Governments have assumed unprecedented roles in the marketplace, much to the advantage of a multi-Trillion global leveraged speculating community. Government market backstops have been instrumental in the mushrooming of global derivative positions to the hundreds of Trillions. A financial insurance marketplace of unfathomable scope has been operating on the flimsy premise of liquid and continuous securities markets. Meanwhile, most economists, “monetary” and otherwise, argue that tame inflation ensures that there is little risk associated with ongoing massive government stimulus and market intervention.

Most today fail to appreciate the potential catastrophic consequences of a crisis of confidence in “money” – a crisis of confidence in the moneyness of government debt and associated obligations. I sense little appreciation for the momentous role played by “money” as the core foundation of overall global Credit – or for Credit as the fuel for global economic activity. We saw again in 2011 how abruptly things can begin to unravel when the marketplace perceives that policymakers don’t have the situation under control. We’ve witnessed, as well, how quickly aggressive concerted global policy responses can transform de-risking/de-leveraging back to re-risking/re-leveraging. In a span of a few weeks, problematically illiquid markets morphed right back into liquidity abundance and speculative excess.

From a monetary and market perspective, we’ve returned to the precarious stage. Risk embracement and leveraging create market liquidity abundance. Strong markets then emboldened the perception that policymakers have everything under control, which stokes even more speculation and stronger risk market inflation. And global risk asset prices - from stocks, to junk bonds to sovereign debt to emerging market debt and equities – enjoy inflated prices based on the view that policymakers can ensure a low-risk macro backdrop. Market players impute moneyness upon Trillions of debt instruments of suspect quality – Credit that will be vulnerable in the next bout of risk aversion and attendant de-leveraging.

I just don’t believe that policymakers have the situation under control. Sure, they can incite a reversal of short positions and risk hedges. They so far retain the capacity to foment “risk on” and speculative excess. Yet, in reality, this is more destabilizing than it is a source of system stability. The amount of mercurial speculative finance has become so enormous as to be unmanageable. When this massive pool embraces risk things can quickly get out of hand (how about $150 crude?). But when this pool inevitably turns risk averse, illiquidity and market disruption once again become immediate problems. And it all hinges on the perception of the efficacy of policymaking and the moneyness of sovereign debt – and, in the end, the sustainability of the massive issuance of non-productive government Credit. The analysis of Bubbles and Bubble dynamics is integral to a Contemporary Theory of Money and Credit.

This afternoon, former Bundesbank Vice President and ECB Executive Board member Juergen Stark warned that public finances in advanced economies were in “dire straits” and that fiscal deficits were “unsustainable.” He was also critical of the ECB bond purchase program, warning that “intervention in the sovereign bond markets postponed adjustment requirements.” I’m with Mr. Stark on this – and I’m with the German economic viewpoint more generally. Indeed, my analytical framework draws heavily from the “Austrian”/German perspective of the overriding importance of stable money and Credit. The Germans well appreciate the danger of monetary inflation, flawed policymaking doctrine, economic maladjustment and Bubbles. And most American economists believe the Germans remain hopelessly fixated on the Weimar hyperinflation experience. I fear our economic community remains hopelessly fixated on flawed economics.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $943bn y-o-y, or 10.1% to $10.253 TN. Over two years, reserves were $2.437 TN higher, for 31% growth.

Total Money Fund assets rose $6.0bn to $2.665 TN. Money Fund assets were down $30bn y-t-d and $85bn over the past year, or 3.1%.

Total Commercial Paper outstanding dropped $24.5bn to $937.6bn. CP was down $109bn from one year ago, or down 10.4%.

Global Credit Watch:

February 23 – Bloomberg (Sandrine Rastello): “The International Monetary Fund will seek to keep its exposure to Greece under a new bailout package at 30 billion euros ($39.8bn), including money still owed from a previous loan, an IMF official said. IMF Managing Director Christine Lagarde has indicated that the fund’s credit to Greece after the second loan will remain at the maximum available under a 30 billion-euro loan agreed in 2010, said the official, who spoke… on condition of anonymity. About 10 billion euros of the first loan hasn’t been disbursed, the official said.”

February 21 – New York Times (Peter Eavis): “Greece's debt restructuring is dragging credit-default swaps back into the spotlight. The last time this financial instrument was on the global stage was in 2008, when the American International Group’s credit-default swaps brought the insurer, as well as the wider financial system, to the brink of collapse. A.I.G. had unique weaknesses, and regulators have started to overhaul the credit-default swap market since 2008. European policy makers have nonetheless looked warily at credit-default swaps, at least until recently, while they structured the Greek rescue over the last six months. They aimed for a voluntary debt exchange that would not initiate the default swaps, fearing that payments on the swaps might set off destabilizing chain reactions through Europe's financial system. But now, with Europe's $172 billion aid package for Greece, it appears that the nation is going to take a step that substantially increases the likelihood that its swaps take effect.”

February 21 – Bloomberg (Marcus Bensasson): “Greece’s economy will contract 4.3% this year and stall next year before returning to growth in 2014 under assumptions used to calculate the country’s debt sustainability before of an agreement on a second bailout. The nation’s debt will peak at 168% of gross domestic product in 2013 and decline to 129% in 2020, according to a base scenario… from the troika…”

February 20 – Bloomberg (Angeline Benoit): “Spain’s debt load is set to double from where it was when Europe’s sovereign debt crisis began, eroding the economic advantages that distinguished it from the region’s periphery and helped shield it from Greek contagion… Spain went into the crisis with public debt of 40% of its gross domestic product, compared with an average ratio of 70% in the euro region. The European Union forecasts its debt will have almost doubled by next year, as Moody’s… says Spain is losing one of its ‘key relative credit strengths.’”

February 23 – Bloomberg (Angeline Benoit): “Spanish residential mortgages decreased for a 20th month in December as the euro area’s fourth-largest economy contracted and banks reined in lending amid a surge in bad loans. The number of home loans fell 37.2% from a year earlier after a 35.8% drop in November... The total amount lent on all mortgages fell 37.4%...”

Global Bubble Watch:

February 20 – Bloomberg (Keiko Ujikane): “Standard and Poor’s affirmed Japan’s sovereign-debt rating at AA-while maintaining a negative outlook and warning that a downgrade is likely if medium-term growth prospects weaken. The ranking is ‘supported by the country’s ample net external asset position, relatively strong financial system, and diversified economy,’ S&P said… It cited the yen’s role as a ‘key international reserve currency.’”

February 20 – Bloomberg (Svenja O’Donnell): “Asking prices for London homes rose to close to a record in February, helping push national values up the most in almost a decade, Rightmove Plc said. Average asking prices in the U.K. capital rose 2.5% from January to 449,252 pounds ($710,300), less than 1,000 pounds below the record reached in October…”

Currency Watch:

The dollar index declined 1.2% this week (down 2.2% y-t-d). On the upside, the Swiss franc increased 2.7%, the Swedish krona 2.6%, the Norwegian krone 2.5%, the euro 2.3%, the South African rand 1.9%, the New Zealand dollar 0.4%, the British pound 0.3%, the Singapore dollar 0.3%, and the Brazilian real 0.2%. On the downside, the Japanese yen declined 2.0%, the Mexican peso 1.1%, the Canadian dollar 0.3%, the Australian dollar 0.1% and the Taiwanese dollar 0.1%.

Commodities Watch:

February 20 – Bloomberg (Chanyaporn Chanjaroen and Nicholas Larkin): “Malca-Amit Global Ltd., a Hong Kong- based company that stores and transports precious metals and diamonds, plans to open a vault in Beijing and is doubling space in Singapore as rising demand spurs gold’s 12th year of gains.”

China Watch:

February 20 – Bloomberg: “China’s January home prices recorded their worst performance in at least a year, with none of the 70 cities monitored by the government posting gains as Premier Wen Jiabao reiterated his determination to maintain property curbs. Prices in 47 of the cities fell, while home values in the remaining 23 were unchanged from December…”

February 20 – Bloomberg: “Lamborghini SpA, maker of the $1 million Aventador LP 700-4, said industry sales of ultra-luxury sports cars may slow as signs that China’s economy is weakening puts off some buyers. ‘If you look at the economy right now, there may be some uncertainty to make people wait a little,’ Christian Mastro, Lamborghini’s Asia Pacific general manager, said… ‘The number of people able to spend this kind of money is limited, it’s not unlimited.’”

February 20 – Bloomberg (Sophie Leung): “Hong Kong’s inflation accelerated to 6.1%, the fastest pace in six months, in January… The increase in the consumer price index from a year earlier compared with 5.7% in December…”

Japan Watch:

February 20 – Bloomberg (Andy Sharp): “Japan posted a record trade deficit in January as the yen’s strength and weaker global demand eroded manufacturers’ profits and slowed the nation’s recovery from last year’s earthquake and tsunami. The gap widened to 1.48 trillion yen ($19bn) and shipments dropped 9.3% from a year earlier as energy imports surged…”

February 24 – Bloomberg (Shigeru Sato, Takako Taniguchi and Mariko Ishikawa): “Japan’s lenders are missing out on a global rally in bank bonds as the central bank warns that their near record holdings of government debt put them at risk of writedowns… A 1 percentage-point increase in benchmark yields would cause a loss of 3.5 trillion yen ($44bn) on Japanese government bonds, or JGBs, held by the nation’s major banks, BOJ Governor Masaaki Shirakawa said…”

Asia Bubble Watch:

February 23 – Bloomberg (Katrina Nicholas): “The region’s biggest lenders say property deals and refinancing will buoy Asia-Pacific syndicated loans in 2012 after the slowest start in eight years… Syndicated lending dropped to $12.8 billion this year, down 71% from the same period last year, making it the worst start since 2004… Companies outside of Japan have as much as $47.9 billion of bank debt to refinance this year and an additional $210 billion before 2016, data on 1,531 loans tracked by Bloomberg show.”

Latin America Watch:

February 23 – Bloomberg (Matthew Bristow): “Brazil’s current account deficit in January was the widest on record after the real appreciated the most of any major currency this year. The deficit in the current account… rose to $7.1 billion from $6 billion in December…”

Unbalanced Global Economy Watch:

February 22 – Bloomberg (Fergal O’Brien): “European services and manufacturing output unexpectedly shrank in February as the euro-area economy struggled to rebound from a contraction in the fourth quarter. A euro-area composite index based on a survey of purchasing managers in both industries dropped to 49.7 from 50.4 in January…”

February 22 – Bloomberg (Johan Carlstrom): “Swedish unemployment rose more than estimated last month as growth slows in the largest Nordic economy… The… unemployment rate… rose to 8% from 7.1% in December…”

February 20 – Bloomberg (Kati Pohjanpalo): “Finnish inflation accelerated in January from the lowest level in a year as taxes on alcohol and fuels increased. Consumer price inflation… accelerated to an annual 3.2% last month, compared with 2.9% in December…”

California Watch:

February 23 – Bloomberg (Alison Vekshin): “After a man with a laptop walked into Best PC Value computer repair in Stockton, California, owner Richard La Frentz telephoned the police. Hours before, the same man had been recorded by a security camera hopping a locked gate behind the store and stealing the computer. The police didn’t come. They told La Frentz to call his insurance company, he said. ‘It is the Wild West out here,’ said La Frentz… who keeps two handguns at his store in Stockton’s Miracle Mile shopping district. ‘When I call the police department, I don’t get help. The city can’t help me because of the condition that it’s in.’ Stockton, an agricultural center of about 292,000, is fighting to avert bankruptcy by shrinking its payroll, including a quarter of the roughly 425-member police force.”

February 24 – Bloomberg (Alison Vekshin and Michael B. Marois): “Stockton, California, may take the first steps toward becoming the most populous U.S. city to file for bankruptcy next week, according to a revised City Council agenda… Local officials will consider whether to begin a type of mediation that allows creditors to participate, the first move toward a Chapter 9 bankruptcy filing under a new state law…”